Royalty increases lead to depressed activity: C.D. Howe

With crude prices remaining relatively strong, provincial governments will be tempted to increase oil and gas royalties to bolster their budgets, but a study by the C.D. Howe Institute says that’s a bad idea.

The study, Rethinking Royalty Rates: Why There Is a Better Way to Tax Oil and Gas Development, concludes that royalties increases backfire by resulting in lower, not higher, government revenue because they depress activity.

According to authors Colin Busby, Benjamin Dachis and Bev Dahlby, provinces are better off relying on auctions for exploration and development rights that promote activity, and relying less on royalties on output.

Alberta found that out the hard way, after controversial oil and gas royalty increases in 2007 led to little total net revenue increase for the province as higher royalties were offset by losses on auction revenues. The increases were later reversed.

“The problem with the current heavy reliance on royalties is that they impede resource exploration and development, whereas upfront auction revenues would not do so,” the authors say. “A shift in emphasis toward auction revenues would have the added benefit of reducing government revenue volatility resulting from short-term energy price shocks.”

The study says the lessons apply to other natural resources.

“Policy makers should think twice about trying to increase revenues from non-renewable resources through higher, economically distorting royalties when a competitive bidding process is in place for exploration and production,” the authors write.